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7.14.2014

The Open Source Challenge for 501(c)(3) Organizations

Recently, Yorba, an open-source software developer that also operates under 501(c)(3) organization rules (like the Mozilla Foundation and the Linux Kernel Organization) found its federal tax exemption status denied.

The Yorba Foundation applied for 501(c)(3) in December 2009. We applied as a charitable, scientific, and educational organization. Remember that we only needed to meet the criteria for one of those to receive 501(c)(3) status.We received two requests for clarification, one on June 23, 2010, and another on September 14, 2010, which we responded to in full. We received a notice on October 5, 2011 that our application was still being processed.

The requests for clarification contained mostly non-surprising questions. For example, “Describe whether your organization provides any goods or services for a fee.” (We don’t.) Some were odd: “Will any of your directors or employees reside at your facility [i.e. our office]?” (Ah…no.)

The final determination letter, the denial of exemption, is dated May 22, 2014,almost four and a half years after we first applied. That strikes me as excessive, particularly since, as the above list of open-source foundations suggests, ample positive precedent existed.

The IRS's reasons for denying the exemption were legally technical. For example, Yorba is unable to show that the poor and underprivileged use Yorba's software exclusively and benefit from the Yorba's software.

Mere publishing under open source licenses for all to use does not show that the poor and underprivileged actually use the Tools. … You do not limit your distribution and do not know who uses the Tools much less if they use them for artistic purposes. … you do not know who uses the Tools much less what kind of content they create with the Tools.

(Here and elsewhere, “Tools” is IRS shorthand for Yorba’s software.)

So it seems like in this case in particular, the IRS's definition and purpose for exempting the 501(c)(3) are not in sync with the software freedoms and the copyleft movement.

The freedom to run the program as you wish, for any purpose (freedom 0).

The freedom to redistribute copies so you can help your neighbor (freedom 2).

The freedom to distribute copies of your modified versions to others (freedom 3).

In other words, we (and, presumably, everyone else) cannot license our software with a GNU license and meet the IRS’ requirements of a charitable organization.

Freedom 1 (“The freedom to study how the program works”) isn’t attacked as non-charitable by the IRS, but it is defined as non-educational:

The purpose of source code is so that people can modify the code and compile it into object code that controls a computer to perform tasks. Anything learned by people studying the source code is incidental.

So as of now, Yorba has accepted the ruling as it stands.

This does not spell disaster for Yorba. The Foundation’s existence does not hinge on 501(c)(3) status. It certainly would’ve been advantageous if the IRS had granted it. It certainly would’ve been a better world if the IRS hadn’t waited four and a half years to inform us of their decision.

We have no plans to appeal their decision. It looks to be an arduous legal battle we cannot afford.

In writing this posting, Yorba is trying to sound the alarm for the types of challenges current and future 501(c)(3) organizations dedicated to open-source software seem likely to face face. Until the IRS accepts the concept that an open-source software organization is an educational and scientific enterprise for the benefit of the community at large (which includes the poor and underprivileged even as it includes commercial enterprises), it seems like the IRS will continue to deny exemption status for nonprofit organizations like Yorba. Lobbying Congress for this kind of recognition is only part of the solution, in the meantime, it behooves nonprofits to start tracking who they are benefitting with their software and how so as to figure out how to gain and retain their exemption status within the current confines of the law.

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I am a lawyer specializing in the areas of sports/entertainment, business, intellectual property and nonprofits. Nothing on this blog is legal advice, it's just information and opinion. If you want legal advice and more, feel free to visit my professional website and hire me. (Fill out this short intake form for a free 15-minute consultation: HERE).